Dark Cloud Cover

The Dark Cloud Cover Pattern is a bearish reversal pattern found at the top of an uptrend, heralding a potential short-term fall in the market.

This is much like a sudden weather change from sunny blue skies to threatening rain clouds.

It is a two-candle pattern where the first day shows:

• a bullish green candle (A) continuing the uptrend, as depicted by the dotted up-trending green arrow.  
• The second candle (B) opens higher than the previous day (A), however, as can be seen from the illustration below, instead of continuing the upward trend indicated by the green trend line, the red candle (price) pushes lower and closes below the open price, bringing with it the potential of breaking the upward trend.
• The key requirement for the Dark Cloud Cover pattern is that the bearish day (red candle or candle B) closes at least half way down the previous day’s candle, as detailed by the dark dotted line shown. The lower the closing price of candle B, the more powerful is the bearish reversal signal. 

Additionally, the higher the gap between the closing price of Candle A and the opening price of Candle B, the more prominent the potential bearish signal is, as the market was unable to sustain the high price level. Also, if volume is high during both days the pattern is said to be more valid.

In the minds of the share market investors and traders, the Dark Cloud Cover pattern signifies that the bulls, which were in control during the uptrend, have theoretically lost confidence in the upward momentum being sustained.

The short-sellers, the so-called Bears have begun to move in and are gaining control. The theory of the mindset of the day-to-day traders is that a seed of doubt has been placed in the Bulls minds. The question posed is will the share price be liable to short-term profit taking or a major reversal? Given this unknown, the Bulls will be less likely to buy at the higher price levels, and the Bears will increase their sales, leading to a lower share price.

Like all Japanese Candlestick patterns, they need the following candle for confirmation. With the Dark Cloud Cover, a bearish candle, as suggested by the dotted red down arrow in the diagram, is required.

Dark Cloud Cover Criteria

The formation occurs after an uptrend or, at times, at the top of a congestion band.

The first real body of the formation is a strong "up."

The second real body's price opens above the prior session's high; however, by the end of the second session, the close has penetrated at least halfway down into the prior session's "up" real body.

Practical Example

The below daily chart of Bluescope Steel (BSL) is a classic example of the Dark Cloud Cover pattern. As can be clearly seen, this bearish reversal pattern heralded in the major short-term reversal in BSL's share price.